Non-Performing Assets represent a default on the loan amount whether principal, interest or both remaining overdue for more than 90 days. The overwhelming burden of NPAs that plague India has had a devastating effect on the growth of the economy, investor confidence and the due process of credit in the industry. This series of articles analyses the new overhauled framework of the Reserve Bank of India aimed at combatting NPAs, its implications on the economy along with the merits and demerits of its stipulations.

The Reserve Bank of India (here-in-after referred to as “RBI) has in the past, undertaken various ambitious endeavours in order to combat the overwhelming and devastating peril of Non-Performing Assets including the Joint Lenders Forum, Corporate Debt Restructuring, Strategic Debt Restructuring, Flexible Structuring of Existing Long Term Project Loans, etc. But, in the wake of the enactment of the Insolvency and Bankruptcy Code, 2016 (here-in-after referred to as “the Code”) which comprehends of an efficacious and holistic insolvency regime, the RBI has furthered the cause of its fight for the effective resolution of stressed assets by employing the Code along with a reformed regime. The past NPA regime of the RBI has been criticized for helping evergreen bad loans and in the ultimate analysis, these tools have generated, what can only be called, shabby results[1]. In view of these flaws, RBI vide its Notification dated 12thof February, 2018 (herein after referred to as “the Notification”) has sought to substitute its existing guidelines and schemes dealing with stressed assets, including the Joint Lender’s Forum in favour of a harmonized and simplified and holistic framework for the resolution of stressed assets that places just reliance on the Code[2]

Under the Notification, upon default by a borrower (of the stipulated magnitude) the lender bank has to implement a Resolution Plan for the purpose of restructuring the account and upon failure of the implementation of this resolution plan for whatever reason, the lender shall make an application for the Corporate Insolvency Resolution Process under the Code.

RBI’s new framework represents a targeted approach that relies heavily on the Insolvency and Bankruptcy Code, 2016 to ensure certainty of process which was in paucity in the previous regime. The main focus of this series of articles is to elucidate upon the modalities and procedure of the new regime of the RBI in dealing with Stressed and Non-performing Assets in contrast to the past regime, along with the thorough analysis of the positive results that have been rendered under the I & B Code in the resolution of NPAs, as these have a substantial bearing on India’s corporate environment. A further point of analysis under these articles is to chart the detailed trajectory of RBI’s exercise of its statutory power to direct banks to initiate insolvency resolution process for the resolution of stressed assets. In pursuit of a holistic approach, while these articles covers the positive effect of RBI’s new NPA regime, they also makes equally placed analysis of its shortcomings and the challenges that lie ahead.

The Code has set in motion a holistic and efficacious insolvency regime which finds harbour and utility in the mandate of various regulatory bodies, like the RBI which now relies heavily on the Code for the resolution of stressed assets. The Code is angled towards a faster, quicker and diligent resolution without any legroom for thriftiness[3]. The Bankruptcy Law Reforms Committee in its Report in 2015 recommended the Code and highlighted the basic problem that the Code endeavours to deal with – “Non-Performing Assets” which is what the RBI, in pursuance of its mandate, seeks to conquer[4].

In the past, though the Code may have set out an efficacious remedy, its exercise was still left as a matter of choice, at the hands of inter-alia, 39 listed banks with an NPA valuation of over INR 4.38 trillions[5]. The reason for inaction on the part of these banks were that firstly, there was no incentive for public sector banks to recognize loss, secondly,the fear of investigation for corruption in the case of low recoveries and lastly, insufficient capital to absorb the losses, prompted most banks to not undertake proceedings under the Code[6]. Further, another factor that must not be ignored is that, though the banks were empowered under the Code, this cause could always be stifled with by corrupt officials, acting on the instruction of the impugned debtor or in furtherance of their own interests. For the reasons previously mentioned, the RBI had the just cause to guide and regulate the effectuation of insolvency proceedings by the banks. This supervisory power of the RBI is a great check on the due process of insolvency, aimed at ensuring that the resolution of stressed and non-performing assets is not stifled by abuse of process.

The aforementioned changes were brought forth by way of the Banking Regulation (Amendment) Act of 2017 (Here-in-after referred to as the “BR Act”) and the formulations of the RBI thereunder.

Understanding the quantum of NPAs in the Indian economy

NPAs have overwhelmed the entirety of the banking system and reached towering stature in the Indian banking sector. The following are the figures of gross NPAs in the Indian economy as on 31st March of each year:

i. 2014 – ₹ 2.5 Lakh Crores

ii. 2015 – ₹ 3.1 Lakh Crores

iii. 2016 – ₹ 5.95 Lakh Crores (Highest rise in a year)

iv. 2017 – ₹ 7.11 Lakh Crores

v. 2018 – ₹ 10.25 Lakh Crores (Highest figure to date)

Over a period of 4 years, India’s NPAs have grown more than four-fold but, the June quarter of 2018 has seen some respite as the gross NPAs as on 30th June, 2018 stood at ₹ 10 Lakh Crores, falling by roughly Rs. 25,000 Crores for the very first time. The major factor behind the same is the successful implementation of the IBC which has substantially furthered the recovery of NPAs both by way of the Corporate Insolvency Resolution Process (CIRP), directly and by way of pre-admission settlements of the claimed amounts, indirectly.

While the causes of NPAs are endless, some of them are Market Failure, Wilful Defaults, Poor follow-up and Supervision, Non-cooperation from Banks, Poor Legal framework, Lack of Entrepreneurial Skills, Diversion of funds, etc.

2. Understanding the effect of NPAs on the Indian economy

NPAs render systemic and far-reaching damage to the health and growth of the economy the consequences of which can be seen on both the macro and micro levels. Some of the many effects include:

i. Higher interest rates on loans leading to reduction in the cash flow in the economy,

ii. Losses to banks which lead to lower return on the shares of the banks,

iii. Loss of investor confidence,

iv. Potential reduction in Government spending, owing to the reduced return to the Government from banks,

v. Hinderance to the growth of the economy,

vi. Reduction in innovation in the country owing to the reduced rate of return,

vii. Rise in the unemployment rates in the economy,

viii. Increase in pressure on the judiciary and the expenditure of banks in the recovery of the NPAs, etc.

This Article is a part of an authoritative series of which other parts are available as under –

Siddharth is the Founder of CorpLexia and serves as its Editor. He is a student of BBA LL.B (Hons.) and has a special focus on corporate, commercial, insolvency, arbitration, securities and competition laws. He can be reached at siddharth@corplexia.com